Electricity Markets Explained

From using business appliances to operating industrial machinery, we’re all connected to the electricity grid day in and day out. Markets ensure that we have a safe and reliable electricity supply to meet demand.

When electricity travels from nationwide generators through to our premises and businesses, there’s lots of work happening behind the scenes to make sure supply is in balance with demand. This work is done through GB’s electricity markets.

But what exactly does that mean and why does it matter?

What are markets?

Before delving into all things electricity, let’s begin with the basics.

In an economic sense, markets enable the exchange of goods or services. They involve transactions between buyers and sellers, either directly or through mediating institutions.

Markets can be literal, like a chain grocery store or local farmers’ market, where buyers can purchase commodities from vendors. In wider systems, however, markets can span beyond physical places. The real estate market and electricity market, for example, include wide geographical areas in which sellers compete.

What are supply and demand?

From industrial machinery to household kettles, electricity demand comes from a wide range of consumer activity. In the electricity market, demand refers to the combined power required by all consumers – both domestic and industrial – at any given time.

Meanwhile, supply comes from electricity generators – including solar, wind, nuclear and other plant types. Generators are responsible for increasing or decreasing the amount of electricity available to meet consumer demand.

What markets exist across the electricity system?

There are several different markets operating across GB’s electricity system, some of the key ones being:

• Wholesale electricity markets include the sale and purchase of electricity between suppliers and generators.
• Retail electricity markets involve suppliers selling electricity direct to consumers.
• The balancing mechanism market refers to how the ESO balances real-time supply and demand through the Balancing Mechanism.
• Balancing services market include the range of services across the ESO that ensure the security and quality of electricity supply across GB’s transmission system.

Who participates across the electricity markets?

There are four main parties in the electricity market, which each play different roles depending on the type of electricity market in question:

• Generators – from renewable resources to fossil fuels, embedded generation to transmission-connected generation – use different fuel sources and technologies to generate electricity.
• Consumers aren’t limited to families turning on appliances in their homes. In the electricity market, consumers also include factories, hospitals, transport and other services that use electricity.
• Suppliers meet generators and consumers in the middle. These companies buy electricity from generators, which they then sell to customers.
• Flexibility providers ensure energy system flexibility, which is the ability to adjust supply and demand to achieve energy balance.

What is the wholesale electricity market?

The wholesale electricity market is where electricity is bought and sold before being delivered to consumers. Its two main participants are generators and suppliers.

In GB, suppliers purchase electricity from generators at a wholesale price, which reflects the cost of electricity generation to meet consumer demand at any given time.

In the wholesale market, there are three main models that determine how wholesale electricity is priced. In Great Britain, we currently use a system called national pricing. This means that at any given moment, there’s one price for wholesale electricity across the country.

The wholesale price of electricity depends on a range of factors, including the level of demand, carbon taxes, cost of fuel and availability of resources like wind and sun. This price therefore fluctuates throughout the day, which can affect which generators are most competitive in the wholesale market.

What is the retail electricity market?

This market involves the selling of electricity from suppliers to their customers. Its main participants are therefore suppliers and consumers.

This retail electricity market is the one that’s most familiar to everyday consumers. When we pay our electricity bills or chose which company supplies power to our homes, workplaces and communities, we’re interacting with the retail electricity market.

Retail market interactions take place after suppliers procure electricity from generators in the wholesale electricity market. Once they’ve bought electricity to meet the demand of their customers, suppliers provide this electricity to their contracted customers across GB.

What’s the role of the electricity market in achieving net zero?

Historically, GB sourced its electricity supply from large coal and gas power stations. But as we’ve transitioned to a more diversified electricity mix to meet decarbonisation goals, the grid has become more complex than ever before.

Markets are key to ensure safe and reliable electricity supply at an efficient cost to consumers – meaning that markets will play a critical role on the road to net zero. Markets need to take us from where we are today to a future energy system that looks very different across supply, demand and networks.

Markets are the revenue streams for electricity system contributors. Their design is therefore critical in enabling the required capacity mix, cost and security of supply needed to achieve net zero.